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Intermediate3 min readTrading and Investing Strategies · 6/10

Investing in Dividend Stocks

Some investors look for companies that pay part of their profits to shareholders in cash each year. The idea is that part of the return arrives as money in hand, not only through the price. But the highest dividend yield does not always mean the most attractive holding.

What you will learn

  • Calculate dividend yield and understand what it measures.
  • Tell a dividend likely to repeat from one that may stop.
  • Recognise the high-yield trap.
In this lesson

Dividend yield

Dividend yield = annual cash dividend per share ÷ share price. A stock at EGP 20 that paid EGP 1.20 over the year yields 6%. Using the dividends of the last 12 months gives the trailing dividend yield, which looks backwards: it tells you what the company paid relative to today's price, and it does not guarantee the same payment next year. Some sources show a forward dividend yield based on the expected dividend or the latest dividend rate, so check which definition is used before comparing.

Will the dividend last?

Dividends come out of profits and cash. So the key questions are: how much of its profit does the company pay out? If it pays most of it, or more than all of it, there is no room if profits fall. Does it have real cash from operations to cover the payment, or does it borrow to pay? And has the dividend repeated over several years, or did it happen once from selling an asset or a one-off gain?

The high-yield trap

Mansoura Dairy
Price20
Last year's dividend1.20
Yield6%
Profits steady; pays about half of them
Sahel Steel
Price12
Last year's dividend1.80
Yield15%
Price fell from 25; profits collapsed
Two invented companies: the higher yield comes from a collapsed price, not a bigger dividend.
Same formula, two different storiesSahel Steel (an invented company) paid EGP 1.80 last year when the stock was at 25, a 7.2% yield. Its profits collapsed and the stock fell to 12, so the yield calculated on the old dividend is now 15%. The figure grew because the price fell, not because the company pays more. If it pays no dividend during the current year, the actual cash yield for the year is 0%, and the price may fall further.

The cash paid out leaves the company itself, which is why the share price can fall once the right to the dividend ends. So a dividend is not a free gain if you buy the day before and sell the day after. The dates are covered in the lesson on the dividend timeline. There may also be taxes or fees on the dividend; ask your brokerage firm what applies to you.

Watch outSorting stocks by highest yield alone can put troubled companies at the top of the list, because their prices have fallen. Look at profits and cash before the percentage.

Look at the dividend history

Open the corporate actions page, find a company that has paid more than once, and compare each year's dividend with its profits.

Check yourself

1. A stock at 40 paid 2 over the year. What is the yield?

2 ÷ 40 = 5%.

2. A yield rose from 7% to 15% in a year with no increase in the dividend. Why, most likely?

The same dividend over a lower price gives a higher percentage. You need to know why the price fell.

Summary

  • Dividend yield = annual dividend ÷ price; calculated on the last 12 months, it looks backwards.
  • Whether a dividend lasts depends on profits, cash and its history, not on the percentage.
  • A very high yield sometimes comes from a price that fell for a real reason.

Related terms

Related lessons

Educational content only, not investment advice. Companies and figures in the examples are invented for illustration.